Gold – the perfect anchor in stormy markets

This is an article that I wrote as a sample for content management company.

“May you live in interesting times” – it certainly seems as if we have all fallen victim to this ancient Chinese curse. We are living at a time that our children will consider to be an important inflexion point in man's economic and financial history. On the one hand there is the massive deleveraging and destruction of credit that is causing deflation and on the other hand there are the stimulus packages and liquidity infusions being passed by the world’s governments and central banks that point to future inflation.

While deflation has the upper hand the only safe asset is cash, but if inflation were to rear its ugly head once again, cash will be the single worst asset to invest in. Inflation would lead to an increase in price levels and hence a loss of purchasing power. To protect wealth one should hold assets that can preserve or store value in the face of a general rise in prices: Real Estate, commodities such as Metals, Coal, Crude Oil and Precious Metals are excellent choices in this scenario.

However deflation would remove the shield that these assets provide. Faced with the “ice” of present deflation and the “fire” of future inflation many investors have been reaching for Gold as an anchor in these stormy times.

Gold has certain characteristics that make it special and different from everything else. All the Gold ever mined in human history, approximately 1,50,000 – 1,60,000 tons is still with us. The supply of Gold is very stable and is around 2% of the total Gold. It takes around 9-10 years for a new Gold mine to come online and then a further 5-7 years for production to hit the market. Thus from exploration to sale Gold from new mines takes about 14-17 years by which time existing Gold mines are in decline. Thus this supply is not very likely to change over time. In fact in recorded human history there has been only one time in which the supply of Gold has increased dramatically, that's when Spain took the Gold of the Incas and Aztecs in the 1600s and flooded Europe with it. Thus if Gold were to be used as money it would be relatively free from increases in supply.

Gold has very little industrial use – other than investment its major use is in jewellery. Gold is almost indestructible and when held as coins or “biscuits” is relatively portable. Gold Markets are very deep and very liquid in fact in Foreign Exchange markets Gold trades like any other currency.

But most importantly when owned without any leverage and in metal form, Gold has no counter-party risk. Like all tangible assets – Gold is no one’s liability and hence when used as a store of wealth is not held hostage to someone’s ability to repay.

Because of these reasons – every prudent investor should own physical Gold as an insurance against unpredictable and “interesting” times.

An American Decline - not a foregone conclusion

It has been my belief, reinforced by the global financial crisis, that the American Century is about to end and the decline of the American Empire about to begin. I have believed that America finds itself where Great Britain was at the end of WWII. Tired and exhausted after fighting multiple wars, its economy ravaged (by war for the British and by a debt fuelled consumption binge in the case of the Americans), its leadership new and untested and a deep malaise affecting all segments of society and popular culture - Pax Americana will end in the same manner that Pax Brittanica did.

I found this article on the Asia Times today:
http://www.atimes.com/atimes/Global_Economy/KB18Dj05.html

The author provides a contrary viewpoint, to paraphrase Mark Twain the rumors of the demise of America have been greatly exaggerated. The article's central premise is that the stable tax revenues that accrue from the world's greatest democracy buttress the US' natural position as an investment safe-haven, this provides a natural source of demand for the US$ and sovereign debt. This demand makes the greenback the world's reserve currency and is the fount of American power.

He argues that other economies such as Germany and Japan have demographic issues that will lead to a decline over time, and China on the other hand is a high risk proposition that may provide higher returns but at the cost of higher volatility - hardly the description of a safe-haven investment.

I don't disagree with his conclusions, but the central premise that American tax revenues are stable, is suspicious in my humble opinion. With a declining economy, falling asset prices, growing unemployment and rising societal acrimony I do not see how tax revenues can remain stable. In fact if you were to pursue the CBO's budgetary projections at: http://www.cbo.gov/ftpdocs/99xx/doc9957/01-07-Outlook.pdf you would see that they agree to a decline in tax revenues in 2009 and then an increase from 2010 onwards. I would wager that the coming global depression will push the rise in tax revenues out for a decade (at least).

With falling tax revenues and hence lower debt service capacity, I do not see how sovereign debt buyers will continue to believe in the credit capability of the US Treasury. Abraham Lincoln once said - You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time. And when you cannot fool the bond market into buying more treasuries - its game over!

A rant on Taxes

Benjamin Franklin is reputed to have said "In this world nothing can be said to be certain, except death and taxes.". I run a (very) small business that develops software to be sold to the construction/infrastructure industry.

What with the prospect of a global depression, the construction industry is not exactly going through a happy phase right now. Consequently the business outlook is exceedingly grim and death" has definitely been on my mind. With "death" so near can "taxes" be very far?

In their infinite wisdom the Income and Excise Tax Departments have come up with a circular stating that all software sold from April 2008 onwards shall be liable to Goods AND Service Tax i.e. software is both a Good as well as a Service. What the Tax Department is saying is that software is both Tangible as well as Intangible, with one deft circular this government department has changed the laws of physics.

This has the immediate impact of applying a 4% Valued Added Tax (V.A.T) AND a 12.36% Service Tax on any product that we sell. Thus increasing the cost of our product by 16.36%. One esteemed cash-strapped customer has flatly declared that he won't pay and that we will have to pay the additional 12.36% tax from our meagre margin.

There's a point where doing the business costs more than not doing the business, and the margin simply cannot be made up in volume. As a result, small independent business owners like myself are simply closing in favor of doing something else. Something easier and more profitable.

Zeitgeist

A sign of the times.

http://www.speroforum.com/a/18056/A-Lesbian-marriage-is-over-in-Massachusetts

Two lesbians who were instrumental in a landmark Court decision- that led to the recognition of same-sex in marriage by a US state have separated. Note the timelines, they were married in May 2004 at the height of the economic boom and asset bull market, and as the market turned so did their marriage.

Social mores and cultural trends reflect the political and economic events of its times. The German philosopher Hegel popularized this notion of "Zeitgeist" as the spirit of an era. The 90's and early '00s were an era of excess, real-estate prices always increased and social conventions rivaled credit and underwriting standards in their permissiveness. All that has changed in this age of the credit crunch, as cash becomes king and liquidity becomes tight look to social attitudes towards marriage and sexuality to become increasingly rigid and inflexible.

China Oh China

The Roubini monitor posted a tidbit from a Chinese Official. According to official figures they've lost about 35 million jobs so far. Given that their labor force is about 450 million. That would put their unemployment rate at about 7.8%.

I think the 2006 India unemployment rate (2006 is the last year for which official figures are available) was about 7.3%. China's unemployment rate in 2006 was 4%. So assuming the same rate of jobless-ness - that would put India's unemployment rate at 14%?

Corporate Social Responsibility

Corporate Social Responsibility is quite becoming the term d'jour in Indian Business circles. During the Republic Day Weekend - my son entered a drawing contest/camp where our kids (who are socially "advantaged") interacted with a bunch of kids who are socially dis-advantaged. Unfortunately these kids came (presumably from their homes or social activity center) after three-quarters of the camp was over - but thats besides the point.

A couple of years ago while I was in business school I read a book called "When Corporations rule the world" by David Korten. It's quite the anti-globalization, anti-privatization tome. But I remember one interesting point that he had noted. Corporate Social Responsibility is dictated by the laws of profit. If a corporate leader chooses to do the 'right' thing vs. the profitable thing, and therefore causes its market value to drop he/she will be fired.

Even assuming that a corporation is able to temporarily persuade its shareholders of the long-term benefits of the "social justice motive". In a global economy those corporations that drink the kool-aid of social justice and sacrifice profit, will be driven out of business by their international competitors.

In India many people point to a company called Fabindia as an example of an organization that practices social justice and shares the benefits of its growth with the community of weavers, artisans and farmers that it sources its products from. As a devoted Fabindia customer I can say that the social justice and inclusive development aspect of its business model is NOT what attracts me to its products.

The fact that a major chunk of the 400 Rupee shirt that I bought will make its way to a weaver makes me feel good about myself but that happens AFTER I have spent the 400 Rupees. If the shirt were to be priced at 4000 or even 1000 Rupees I would not have bought it. Even if an expensive shirt might have meant increased earnings for the weaver and his family.

We consumers buy Chinese products because they are good enough and they're cheaper than comparable American/European/Indian products. Consumers practice morality with their wallets. In a world where money is a scarce economic good people will inevitably spend their money where they perceive the highest value to themselves. Most people do not feel rich enough to change the world by paying more than we have to for the goods that we consume.

Organizations that trumpet corporate social responsibility and social justice as being central to their mission are doing their shareholders and themselves a disservice. An approach that relies on corporate and individual social responsibility to change the world - is doomed to failure. This approach will run up against a wall of individual self-interest and stall there.

Luck By Chance

The wife and I saw the latest Farhan Akhtar vehicle "Luck By Chance". While a decent movie, with excellent character development, the theme of bollywood takes a look inside bollywood left me a little cold.

The pluses were the smartly written dialog and excellent screenplay. Farhan and Konkona as the Bollywood strugglers willing to do what it takes (aka "compromise") to get ahead were solid without being exceptional. Some great cameos from Anurag Kashyap, Rishi Kapoor, Juhi Chawla amd Hrithik Roshan. A bunch of Bollywood superstars had walk-on parts so that may have been interesting for those who look out for such things.

Personally I thought it OK for the multiplex crowd and decent "time-pass" if nothing else.